Private Placement: A Guide to Section 42 of Companies Act 2013

Summary: Private placement is a method for a company to raise capital from a select group of people rather than through a public offering. This process is governed by Section 42 of the Companies Act, 2013, and is meant to be a private and non-advertised affair. To prevent misuse, like in the Sahara case, there are strict conditions. A company can only make an offer to 200 people per financial year for each class of securities, excluding qualified institutional buyers and employees under ESOPs. The funds must be received through banking channels and the securities must be allotted within 60 days. The procedure involves board and shareholder approval, preparing an offer letter (PAS-4), receiving application money into a separate bank account, allotting securities, and filing a return of allotment (PAS-3) with the Registrar of Companies. Non-compliance can lead to hefty fines for both the company and its directors, and the money raised must be refunded. While private placement offers a flexible way for companies, especially startups, to raise funds, strict adherence to the law is necessary to avoid significant penalties.

What is Private Placement?

Under Section 42 of the Companies Act, 2013 provides that a company can make a private placement to a selected group of persons. Private Placement by companies means offering its securities or inviting to subscribe its securities for a select group of persons other than by way of a public issue through a private placement offer letter.

A company making a private placement cannot offer its securities through any public advertisements or utilize any marketing, media, or distribution agents or channels to inform the public about such an offer. If the offer is advertised or marketed, it will be considered a public offer and not a private placement by the company.

The law has been substantially amended to prevent misuse, particularly in the aftermath of the Sahara Case, where Sahara India Real Estate Corporation raised money from millions of investors under the guise of private placement.

Key Conditions:

• Offer can be made to not more than 200 persons in aggregate in a financial year for each class of securities (Equity Shares, Preference Shares, Debentures).
• The limit of 200 excludes:  a.} Qualified Institutional Buyers (QIBs) b.}Employees offered securities under ESOP (as per Section 62(1)(b)
• Subscription money to be received only through banking channels (no cash allowed).
• Securities to be allotted within 60 days of receiving application money.
• Company shall not utilize monies raised through private placement unless allotment is made and the return of allotment is filed with the Registrar.
• No fresh offer or invitation under this section shall be made unless the allotments with respect to any offer or invitation made earlier have been completed or that offer or invitation has been withdrawn or abandoned by the company.

Procedure for Private Placement (Step-by-Step)

1.Board Meeting

• Approve proposal for private placement.
• Identify persons to whom offer will be made.
• Approve draft PAS-4 and call for shareholders’ meeting.

2. Shareholders’ Approval

• Pass a special resolution (Form MGT-14 to be filed with ROC).
• For non-convertible debentures (NCDs), ordinary resolution is sufficient if borrowings are within the borrowing limits under Section 180(1)(c).

3. Preparation of Offer Letter (PAS-4)

• Circulated only to identified persons (not more than 200).
• Company must maintain a complete record of offers in Form PAS-5.

4. Receipt of Application Money

• Only by cheque, demand draft, or banking channels (no cash).
• To be kept in a separate bank account in a scheduled bank.

5. Allotment of Securities

• Must be completed within 60 days of receipt of money.
• If not allotted, refund within 15 days; else, money attracts interest @12% p.a.

6. Filing with ROC

• File PAS-3 (Return of Allotment) within 15 days of allotment.

7. Issuance of Certificates

• Share certificates to be issued within 2 months from allotment.

Penalties for Non-Compliance (Section 42(10)

• Company: Penalty up to amount raised through private placement or ₹2 crore, whichever is lower.
• Promoters & Directors: Penalty up to ₹25 lakhs.
• Money raised must be refunded to subscribers within 30 days of the penalty order.

Conclusion

Private Placement is a flexible and cost-efficient route for raising capital, especially for start-ups, private companies, and even listed entities seeking strategic investors. However, the legislative intent after the Sahara debacle is to ensure transparency and prevent misuse.

Thus, companies must ensure strict adherence to:

• Section 42 of the Companies Act, 2013
• Rule 14 of Companies (Prospectus and Allotment of Securities) Rules, 2014
• MCA circulars and notifications

Any non-compliance not only attracts hefty penalties but may also reclassify the issue as a public offer, leading to even stricter SEBI regulations.